Although currently there is tremendous focus on who President Biden will nominate as the next Chair of the Federal Reserve, and appropriately so, the four-year term of the current Vice Chair for Supervision (VC Supervision), Randal Quarles, is expiring on October 13. This position has significant importance for financial stability and the safety of the U.S. banking system, especially so after the last four years of dangerous Trump-era deregulations that were pushed by VC Supervision Quarles with the support of Fed Chair Jay Powell and others.
The VC Supervision is the head of the Fed’s Committee on Supervision and Regulation, which can have tremendous influence over the setting of rules for and supervisory oversight of the U.S. banking system, an important member of the Financial Stability Board, and a key U.S. representative to the Basel Committee on Banking Supervision. The next VC Supervision must use all of these platforms to pursue an agenda of “re-regulating” the banking system to promote a safer financial system by more fully addressing the challenges of too-big-to-fail, which has grown larger and more dangerous.
This starts with undoing the most dangerous deregulation carried out since 2017. First, the Fed’s supervisory stress test must be strengthened and made more dynamic. Second, the requirement that banks be able to meet minimum leverage requirements even after accounting for the losses estimated in the stress test should be restored. Third, the unnecessary weakening of liquidity requirements for large banks with between $250 and $700 billion in assets should be reversed, and the Net Stable Funding Ratio liquidity regulation should be reverted to its originally proposed form. Fourth, the original form of the Volcker Rule should be adopted and made broader and stronger. Fifth, the Fed should reinstate the requirement for the posting of collateral on derivative transactions between a bank and its affiliates.
Other key regulations should be strengthened to go even further than they had in their initial form. Making large banks prepare for possible resolution is critical to addressing the TBTF problem, and so the submission of so-called “living wills” should not only return to a two-year cycle to increase their relevancy but also many of the Fed’s resolution plan expectations should be made part of legally constraining rules, rather than part of non-binding ”supervisory guidance.” Additionally, the pandemic-caused financial and economic stress, as well as the 2008 Crash, have highlighted issues that should lead to further enhancements of regulatory requirements. For example, in both events money market funds proved to be a source of fragility and material risk. Such issues highlight that capital requirements for large banks should be higher and that the Fed should be rethinking its capital requirements. More generally, the next VC Supervision should assess what other modifications could be made to the regulatory framework to enhance the safety and soundness of the banking system.
On the bank supervision front, the effective elimination of the so-called “CCAR qualitative objection” to bank capital distributions significantly weakened large bank supervision, and its use should be fully restored. The Fed’s supervisory assessments should be expanded at the largest banks to include a greater explicit focus on the effectiveness of boards of directors, and consideration should be given to requiring independent board chairs rather than allowing CEOs to also be board chairs. The supervisory process must be made more transparent, including the increased usage of public enforcement actions, to provide stronger incentives to banks and ensure public accountability not only of the banks but of the Fed itself. Importantly, the supervisory assessment framework must also include formal assessments on climate change-related issues, and stress testing scenario analysis should be used to inform supervisors of banks’ climate risks.
In addition to promoting a safer banking system, the next VC Supervision must work to improve the economic well-being of low- to moderate-income (LMI) communities, including communities of color, by promoting increased access to credit and other financial services. A key way this can be accomplished is by improving, strengthening and broadening Community Reinvestment Act (CRA)-related regulation. Fees charged by banks for various financial services and other factors, such as required checking account minimums, should be closely monitored along with the other regulatory agencies to determine the best way to encourage banks to make banking fair and accessible.
There are also new and emerging risks to assess and address. The rise of financial technology (FinTech) companies has altered the dynamics of the banking system and introduced competition that is broadly unregulated. “FinTech” can’t be allowed to be the latest label to obscure yet more creative ways to extract money from financial consumers while increasing systemic risk.
The right set of actions by the next VC Supervision will get back on the path of finishing the job started by DFA to address the TBTF problem, helping to promote greater resiliency of our financial system, and can promote an economy that works better for all Americans.